Letter of Intent (LOI)

A Letter of Intent (LOI) is a document that outlines the preliminary understanding and key terms between two or more parties before a formal, legally binding agreement is finalized. Think of it as a “handshake on paper” in the world of big deals, particularly in Mergers and Acquisitions (M&A). While it signals serious intent from both the buyer and the seller, most of its content is not legally binding. Its primary purpose is to ensure all parties are on the same page about the major deal points—like price, structure, and timing—before they invest significant time and money into the next steps, such as extensive due diligence and drafting a definitive purchase agreement. For investors, it's the first concrete step in turning a potential opportunity into a tangible deal, laying out a roadmap for the transaction. It's similar in spirit to a term sheet, though often more detailed and formatted like a formal letter.

An LOI isn't just a simple letter; it's a carefully structured document that sketches out the skeleton of the potential deal. While the specifics can vary, a typical LOI will include several key provisions. These terms set the stage for the formal negotiations to come. Here are some of the most common components you'll find:

• Transaction Overview: A brief description of the proposed deal (e.g., “Party A intends to purchase 100% of the shares of Party B”).
• Purchase Price & Structure: This section outlines the proposed price and, just as importantly, how it will be paid. Will it be all cash, stock in the acquiring company, a seller's note, or some combination?
• Due Diligence Plan: The LOI grants the buyer permission to conduct due diligence—a deep investigation into the seller's business, financials, and legal standing. It may also define the timeframe for this investigation.
• Key Conditions & Contingencies: These are the “if-then” statements of the deal. The transaction may be conditional upon the buyer securing financing, receiving board approval, or the absence of any major negative findings during due diligence.
• Binding Clauses: This includes specific sections that are legally enforceable, such as confidentiality and exclusivity (more on this below).
• Timeline: A proposed schedule for completing due diligence and reaching a final, definitive agreement.

An LOI isn't just administrative paperwork; for a savvy value investor, it's a critical strategic tool. Value investing is about buying great companies at a fair price, which requires deep, meticulous research. The LOI acts as a gatekeeper to this process. By signing one, an investor can often secure an exclusivity clause, which prevents the seller from shopping the deal around to other potential buyers for a set period. This “quiet time” is invaluable. It allows the investor to conduct thorough due diligence without the pressure of a bidding war, ensuring they can verify the company's true value and uncover any hidden risks. The LOI effectively locks in the preliminary terms based on initial analysis, giving the value investor the breathing room to confirm their investment thesis before committing fully. It transforms a competitive situation into a controlled, one-on-one negotiation, which is a far better environment for making a rational, value-based decision.

It’s crucial to understand that an LOI is a gentleman's agreement with a few legally enforceable teeth. While the core commercial terms like the purchase price are typically non-binding—meaning either party can still walk away if they can't agree on the final details—certain clauses are almost always legally binding.

• The Exclusivity Clause: Also known as a “no-shop” agreement, this legally prevents the seller from soliciting or negotiating offers from other parties for a specified time. If the seller breaks this promise, they could be sued for damages. This is the buyer's reward for committing time and resources to due diligence.
• Confidentiality Agreement: Both parties are legally bound to keep the deal discussions and any shared sensitive information secret. This protects the seller's trade secrets and the buyer's strategic plans.
• Governing Law: This clause specifies which jurisdiction's laws will be used to interpret the binding parts of the LOI.

Always read the fine print! The LOI sets the stage for the final contract, and these binding clauses protect both the buyer and seller during the delicate dance of negotiation.

Imagine a value investor, “Valerie,” has her eye on “SteadyEddie's Hardware,” a private company she believes is undervalued. After initial talks, Valerie and Eddie sketch out a deal.

1. Step 1: The Handshake. Valerie offers to buy the company for $5 million. Eddie, the owner, is interested.
2. Step 2: The LOI. To make things official, Valerie's lawyer drafts an LOI. It states the $5 million price, that the deal will be all cash, and that Valerie has 90 days to conduct her due diligence. Crucially, it includes a binding “no-shop” clause, meaning Eddie can't talk to other buyers for those 90 days.
3. Step 3: The Deep Dive. Both sign the LOI. Now Valerie has the exclusive right to dig into SteadyEddie's financials, contracts, and operations. She confirms her initial assessment of the company's value and finds no nasty surprises.
4. Step 4: The Final Agreement. With due diligence complete and successful, the lawyers draft the final, fully binding purchase agreement based on the terms established in the LOI. The deal closes, and Valerie is the proud new owner of an undervalued asset.